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Is Zhejiang Expressway Co., Ltd.'s (HKG:576) P/E Ratio Really That Good?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Zhejiang Expressway Co., Ltd.'s (HKG:576), to help you decide if the stock is worth further research. What is Zhejiang Expressway's P/E ratio? Well, based on the last twelve months it is 5.97. In other words, at today's prices, investors are paying HK$5.97 for every HK$1 in prior year profit.

View our latest analysis for Zhejiang Expressway

How Do You Calculate Zhejiang Expressway's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Zhejiang Expressway:

P/E of 5.97 = CN¥5.288 ÷ CN¥0.886 (Based on the year to September 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CN¥1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Zhejiang Expressway Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (7.2) for companies in the infrastructure industry is higher than Zhejiang Expressway's P/E.

SEHK:576 Price Estimation Relative to Market, March 8th 2020

This suggests that market participants think Zhejiang Expressway will underperform other companies in its industry. Since the market seems unimpressed with Zhejiang Expressway, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Zhejiang Expressway's earnings per share grew by -8.2% in the last twelve months. And it has bolstered its earnings per share by 12% per year over the last five years.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Zhejiang Expressway's Balance Sheet Tell Us?

Zhejiang Expressway's net debt is 60% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Zhejiang Expressway's P/E Ratio

Zhejiang Expressway has a P/E of 6.0. That's below the average in the HK market, which is 9.7. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Zhejiang Expressway may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.